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Aug 07

The disappearing credit spread…US now at pre-GFC levels

US Bond Spreads - August 2014

Source: RBA

I know this probably an overly simplistic way of looking at investment grade credit markets…but…the above chart is currently showing that US investment Grade credit spreads have declined to be in the ballpark of pre-GFC levels. Personally, the US economy is still relatively weak, albeit getting stronger, but I no longer believe this type of credit risk appears as good value and today I would rather own safer US Treasuries than US Corporate debt…why…greater protection alongside of riskier assets such as equities, therefore as far as I’m concerned Treasuries have a better risk-adjusted expected return.

According to Moody’s the worst default rate of BBB rated securities over the last 30 years was a little over 1% which occurred in 2002. The current spread provides a little more than that so there is only a little compensation for other risks such as illiquidity if things go tech-crash pear shape.

Anyway, no matter how you look at it the chase for yield from lower rated credit risk is definitely approaching its end and whilst Australian credit looks a little better or wider (see below chart), our unemployment rate didn’t increase to 6.4% for nothing…that is, our investment grade debt should have a wider spread as our economy is looking like doing nothing more in the next couple of years but weakening.

Aust Bond Spreads - August 2014

Source: RBA

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6 comments

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  1. Brian Howard

    Hi Michael, Another very interesting missive from you – thank you! I’d be fascinated to read why you think the US is in a recovery. Please don’t quote US govt or mainstream media lies (such as false jobs figures or govt inflation calcs that exclude food and energy!) – independently sourced figures would be appreciated. Cheers, Brian.

    1. michael

      Thanks very much Brian. Hopefully I haven’t suggested that the US is recovering strongly because it hasn’t been and it still isn’t. Last week’s Federal Reserve announcement that they are decreasing their asset purchase program is a positive sign…cutting a long story short, the US is on the improve relative to its recent history whilst Australia is increasingly facing headwinds as the resources investment boom grinds to a halt. Certainly is the recovery wasn’t underway they would probably maintain their quantitative easing program but smoke and mirrors or not, there is still unemployment improvement compared to a few years ago. I know you asked me not to quote US government lies but please keep in mind that the Federal Reserve is an independent agency outside of government…and, disclosure, I’ve always been a fan of Janet Yellen!

      1. Brian Howard

        If the US govt stops their ‘asset purchasing prog’ (AKA money printing out of thin air/increasing their debt exponentially) then rates will punch so high the country will race to a halt. The ‘bond buying’ by the Fed is disgraceful and an unmitigated disaster for future generations. The government of the US, each member of congress, should be embarrassed, ashamed, sickened and terrified for their children and grandchildren about creating a debt that can never be repaid without inflating it away (horror story itself) or international default. Henry Ford is famous for the quote” If the average American knew how money was created and the ramifications there would be revolution in the streets tomorrow morning” He was, of course, referring to the immoral ‘fractional reserve system’ which indentures all workers as slaves of the Fed forever. Contrary to popular belief, the Federal reserve exists for only one reason – to look after the banks and their interests. It was created under cover of darkness in a clandestine midnight law-passing session in 1913 when nobody outside the circle was there to vote it down. This stuff is all on record if anyone cares to look. The chief of all scoundrels who headed the small group of bankers that night, Rothschild, was quoted the days after saying “give me control of a country’s currency printing and I care not who writes it’s laws” Chilling stuff and we can see the result of this abomination called the Fed – over 90% of the value of the US dollar has been eroded since 1913. God help them when it collapses sometime very soon.

        1. michael

          HI Brian, we’ll probably have to agree to disagree with respect to the bond buying. There’s very little evidence that interest rates will shoot up should the bond buying stop…lets face it when it stopped in the past things got worse so they had to restart. If bond buying suddenly stops (emphasis on suddenly) you will probably see the economy decline and deflation concerns along with it…that definitely doesn’t add up to higher bond yields but the opposite. The Fed’s actions since the GFC have been designed to stop a Japanese type situation and the belief that inflation skyrockets with zero cash interest rates in the face of a consumer confidence crisis has clearly been weak. The bond buying is simply an attempt to kickstart the economy and stronger economic growth is a far more efficient way of reducing future debt than fiscal austerity which can actually makes things worse (e.g. Europe) in this current global context.

  2. bob

    Could you please explain why you feel the economy is going to become weaker? I think we will start to see proper growth from mid 2015 onwards.

    1. michael

      Basically the Australian economy for many years now was largely driven by the China led Resources boom that created massive investment in the production phase…this led to lots of local jobs from foreign investment in this boom. That economic driver is coming to an end as the Resources boom moves to the selling phase…which is great for company profits (of which 80% give or take heads overseas), but doesn’t do a great deal for the Australian economy or jobs. Its even worse if the Australian dollar stays high and therefore discourages foreign investment due to a high perceived cost. Australia has amongst the highest wages in the world and this explains the massive decline in Australian manufacturing to name just one industry.
      In contrast, the US economy’s rate of growth appears to be on the increase as more manufacturing returns home and their significant energy boom (think shale gas) contributes to growth.
      I’m not saying US growth will be more or less than Australia’s but the trends appear to be somewhat in opposite directions.

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